DEFINITION of hard call protection
Protection against firm calls is the period of the life of a redeemable bond during which the issuing company is not authorized to redeem the bond. This protection generally lasts for the first three to five years of the bond’s life.
Protection against hard calls is also called absolute protection against calls.
BREAKING HARD CALL PROTECTION
Investors who buy bonds receive interest over the life of the bond. When the bond matures, bond holders receive repayment of the principal value equivalent to the nominal value of the bond. Interest rates and bond prices have an inverse relationship – the value of a bond decreases when prevailing market interest rates rise, and vice versa. While bond holders prefer to invest in higher rate bonds as this translates into high interest income payments, issuers prefer to sell lower rate bonds to reduce their cost of borrowing. Thus, when interest rates fall, issuers will withdraw existing bonds before they mature and refinance the debt at the lower interest rate reflected in the economy. Bonds that are redeemed before maturity stop paying interest, forcing investors to find interest income on certain other investments, usually at a lower interest rate (risk of reinvestment). To protect callable bondholders from paying their bonds too early, most trust agreements include protection against hard calls.
Protection against firm calls is the period during which an issuer cannot “call” its obligations. Corporate and repayable municipal bonds typically have ten years of call protection, while public debt protection is often limited to five years. For example, consider a bond issued with a maturity of 15 years and call protection of 5 years. This means that during the first five years of the bond’s life, regardless of the movement of interest rates, the bond issuer cannot repay the principal balance of the bond before maturity. of obligation. Hard call protection serves as a sweetener because it guarantees that investors will receive the declared return for five years before the bond can be called.
After the expiration of the hard call protection period, the connection can continue to be partially protected by flexible call protection. This functionality requires that certain conditions exist before the link can be called. Soft call protection is generally a premium at par that the issuer must pay to call the bonds before maturity. For example, the issuer may be required to repay investors 103% of the total face value of the bond on the first date of redemption. A soft call clause can also specify that the issuer cannot call a bond which is trading above its issue price. In the case of convertible callable bonds, soft call protection would prevent the issuer from calling the bond until the price of the underlying stock reaches a certain percentage above the conversion price.
Redeemable bonds offer a higher return because of the risk that the issuer will repay them before maturity. A retail ticket is an example of a type of bond that typically includes hard call protection.